The Big Chill In Seed

This weekend, I wanted to write a few posts about the state of early-stage markets. Last night, I wrote a longer post about the different world seed founders should expect as they try to raise their coveted Series A rounds. I was surprised at the way it flew around Twitter. My posts rarely get that much pick-up.

There was a related topic I was going to touch on, but I’m glad I saved it for a separate post here. The topic: That the ecosystem should expect pre-seed and seed valuations to cool down. Note, they’ll still be quite attractive for founders, but I believe they’ll shift down. I can’t prove it with data, but that is my intuition. Why?

(1) Summer Slump. The fatigue I explained in my previous post is also rippling through seed, though it’s of a different variety, specifically around being disciplined on valuation.

(2) M&A Sleepy. Not Many IPOs. Seed has now been professionalized for 5+ yrs, and folks have seen the data. Whereas the bigger VCs have to pay up, they get more data and see more mature companies; the seed folks, on the other hand, run the risk of funding into a red ocean filled with competitors and are often blindsided when this rears its head. There’s not much M&A to write home about, and even fewer tech IPOs in 2015. A $20m exit as acqui-hire on a $12m cap in seed doesn’t rile up the natives.

(3) Questions From LPs. A few little M&A activity and LPs will start to inquire “Do we get some distributions?” Yet, most of these are smaller, and with a higher entry price as seeds have creeped up over the past few years, it turns what would’ve been decent to a wash on the balance sheet. Part of this is to blame on bad picking, but also at seed, so much of it is hit or miss, and very few people pick consistently well so early. (Many of the folks who are known for a few signature deals have likely done many others they don’t publicize.)

(4) Knowing Series A Investors Are Wary. As I wrote last night, whereas Seed and Series A markets are different, all of these markets are interrelated, and after a few years, seed investors have likely noticed only a percentage of their carefully picked portfolio actually graduates to A. After a few years, the pattern becomes engrained.

(5) Optimizing For Partnership. Seed is frenetic, can feel transactional with different note structures, deadlines with caps, little to no information sharing, and so forth. But, in my conversations, seed investors seem to be less worried now about FOMO if in exchange they can find founders who want to work with them and actually develop a partnership that works both ways. I have found, much to my surprise, that many founders inside Haystack have gone to bat for me over and over again. In some cases, a founder has helped me more than I’ve helped them.

There’s so much money in seed (mine included), and more money coming — I’ve heard from folks in NYC and other places that we will have even more micro-funds forming. I am not writing about sour grapes — I am part of that movement, or problem. But for the firms and seed investors that have been doing it for a few years, entirely in this up market, I believe we are now past the peak of seed valuations and high caps for not-yet-proven models.

To be clear, if a seed-level startup is cranking, pulling down revenues, and showing signs of great promise, a seed fund is willing to pay $12-15m as an entry price on valuation, betting the bigger VCs 3-4x that price if things work out. However, in the absence of traction, technology achievement, or being a founder with demonstrable entrepreneurial talent, I’d expect $8m to be the new ceiling for entry price on valuation caps, and that’s for the opportunities in higher demand — most will settle around $6m.

Not much I can do to prove it, but it’s something I think about, talk about, and monitor every day. My two cents. Or, my 600m cents. By the way, $6m-8m for seed entry price is still pretty damn good, so this isn’t meant to be a downer-post, but more of a sober prediction (a “big chill”) now that we’ve all had a few cycles under our collective belts in this new world of atomized VC.

Haystack is written by Semil Shah, and is published under a Creative Commons BY-NC-SA license. Copyright © 2018 Semil Shah.

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